Tuesday, August 23, 2011

What's wrong with the gold standard

The simplest way to see this is to think about what’s not wrong with the current system. Suppose that you have a pile of U.S. dollars. One hundred thousand of them. And you think that you have a problem. Inflationistas at the Fed are going to reduce the value of your pile. You think the solution to this is to take away the Fed’s discretion over the supply of dollars, and mandate that each dollar be backed by a specific quantity of gold. This, you think, will protect the value of your dollar stockpile by linking it to long-run trends in the supply of and demand for gold. Maybe you’re right that a pile of fiat dollars is a worse investment than a pile of gold-backed dollars and maybe you’re right. But if this is your issue, nobody is stopping you from trading your fiat money for gold. Other people who would rather have fiat money than gold will sell it to you. I promise. This exchange of fiat money for gold happens every day, and you, too, can participate in it.

Interestingly, what won’t give you the security you crave is the adoption of a gold standard. If a federal law mandates that $1,000 be worth a certain amount of gold, there’s nothing stopping congress from changing the law later. If you want the alleged security of gold, there’s no substitute for gold. A gold standard is neither necessary nor sufficient.

Nor does gold ensure stable prices. What it ensures is that inflation trends are driven by the supply of gold. Find a new gold mine somewhere: inflation. Aliens come to steal gold: deflation. All you’re doing is randomizing the extent and timing of inflation.